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Commodities are raw materials like gold, oil, and wheat that trade on exchanges. Here's how commodity investing works, why prices move.
This guide is designed for first-pass understanding. Start with core terms, then apply the framework in your own account workflow.
Commodities; gold, oil, natural gas, wheat, copper — are the raw materials that power the global economy. They're also an asset class that most individual investors either ignore or misunderstand. Commodities behave differently from stocks and bonds, they've historically served as an inflation hedge, and there are now several accessible ways to add commodity exposure to a portfolio without ever touching a futures contract.
Commodities are standardized, interchangeable raw materials; like gold, crude oil, natural gas, copper, wheat, and coffee; that trade on specialized exchanges through futures contracts. Unlike stocks, commodities produce no earnings or dividends; returns come entirely from price changes driven by global supply and demand. Commodities serve as an inflation hedge and portfolio diversifier, with most financial advisors suggesting a 5-10% allocation for investors seeking broader diversification. The easiest way to invest is through commodity ETFs like GLD (gold) or broad baskets like DBC.
A commodity is a standardized, interchangeable raw material or primary agricultural product. One barrel of West Texas Intermediate crude oil is identical to any other barrel of WTI crude. One ounce of 99.99% pure gold is the same as any other ounce. This fungibility; the property of being interchangeable; is what makes commodities tradeable on exchanges.
Commodities fall into several broad categories:
Commodity prices are driven by supply and demand fundamentals; weather affects crop yields, OPEC decisions affect oil supply, industrial growth affects metal demand. Unlike stocks, commodities don't generate earnings or pay dividends. Their returns come entirely from price appreciation (or depreciation).
Most commodity trading happens through futures contracts; agreements to buy or sell a specific quantity of a commodity at a predetermined price on a future date. Futures were originally created for producers and consumers to lock in prices. A farmer could sell wheat futures at planting time to guarantee a price at harvest, and a bread company could buy wheat futures to guarantee its input costs.
Commodities are basic raw materials that are interchangeable with other goods of the same type. They include energy (oil, natural gas), metals (gold, silver, copper), and agriculture (wheat, corn, coffee). They trade on specialized exchanges through futures contracts.
The easiest way is through commodity ETFs (like GLD for gold or USO for oil). You can also buy stocks of commodity producers, invest in commodity mutual funds, or trade futures directly — though futures are complex and not suitable for most individual investors.
Gold and commodities broadly have historically risen with inflation since they're priced in dollars. However, they produce no income (no dividends or interest) and can be highly volatile. A small allocation (5-10%) can provide portfolio diversification and inflation protection.
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Today, most futures trading is done by speculators and financial institutions, not farmers and bread companies. The futures market is enormous; trillions of dollars in notional value — and it's the primary mechanism for commodity price discovery.
Individual investors generally should not trade commodity futures directly. Futures are leveraged instruments (you only put up a fraction of the contract value as margin), they expire and must be rolled over, and they can generate complex tax situations. They're powerful tools for professional traders but unnecessary and risky for most individual investors.
Exchange-traded funds have made commodity investing accessible to everyone. The major commodity ETFs include:
| ETF | Commodity | Backing | Expense Ratio |
|---|---|---|---|
| GLD | Gold | Physical gold | 0.40% |
| IAU | Gold | Physical gold | 0.25% |
| SLV | Silver | Physical silver | 0.50% |
| USO | Oil | Futures-based (contango risk) | 0.60% |
| DBC | Diversified basket | Futures-based | 0.85% |
There's a critical distinction between physically-backed ETFs (like GLD, which holds actual gold) and futures-based ETFs (like USO, which holds futures contracts). Physically-backed ETFs track the spot price accurately. Futures-based ETFs can deviate significantly from the spot price over time due to the cost of rolling futures contracts.
The most common reason investors add commodities to their portfolio is inflation protection. The logic is straightforward: when the prices of goods and services rise (inflation), the prices of the raw materials that make those goods should rise too. Oil, food, and metals get more expensive in nominal terms, so holding them preserves purchasing power.
The historical evidence is mixed but generally supportive. Commodities have shown positive correlation with inflation over long periods, particularly during episodes of high or unexpected inflation. During the 1970s inflation spike, commodities significantly outperformed stocks and bonds. During the 2021-2023 inflation surge, energy and agricultural commodities again delivered strong returns while bonds got crushed.
However, commodities are a noisy inflation hedge. In any given year, commodity prices are driven more by supply-demand factors specific to each commodity than by broad inflation trends. Oil can crash during an inflationary period if there's a supply glut. Gold can rally even with low inflation if there's geopolitical uncertainty. Over the short term, commodities are not a reliable inflation hedge; they're a volatile asset class that happens to have inflation-hedging properties over longer periods.
Gold deserves special attention because it plays a unique role. Unlike other commodities, gold's value is primarily driven by its status as a store of value and a safe-haven asset, not by industrial demand (though industrial use exists, particularly in electronics).
Arguments for holding gold:
Arguments against gold: it generates no income (no dividends, no interest), its long-term real return is roughly zero (it preserves purchasing power but doesn't grow it), and it can have long periods of underperformance; gold went nowhere from 1980 to 2005.
Most financial advisors who recommend gold suggest a 5-10% portfolio allocation. Enough to provide diversification and crisis protection, but not so much that the lack of income generation drags on long-term returns.
Oil is the most economically significant commodity. It affects everything from transportation costs to manufacturing to the price of food (farming runs on diesel). Oil price movements ripple through the entire economy.
Rising oil prices act as a tax on consumers and businesses, slowing economic growth. Falling oil prices stimulate growth by lowering costs. This relationship makes oil a complex investment; it tends to do well when the economy is overheating (strong demand) and poorly during recessions (weak demand).
The oil market is heavily influenced by geopolitics. OPEC+ (the Organization of Petroleum Exporting Countries and allies, including Russia) controls a significant portion of global oil production and adjusts output to manage prices. Sanctions, wars in oil-producing regions, and production decisions by Saudi Arabia and Russia can move prices dramatically.
For individual investors, oil exposure through diversified energy ETFs or broad commodity funds is generally preferable to pure oil bets through USO or similar products, due to the contango issue discussed below.
Commodity markets move in long supercycles; extended periods of rising or falling real prices driven by structural shifts in supply and demand. Historical supercycles have lasted 15-25 years:
Some analysts argue a new supercycle began in the early 2020s, driven by electrification (massive demand for copper, lithium, cobalt, nickel), green energy transition, years of underinvestment in new supply, and deglobalization trends. If they're right, commodities could outperform for the next decade or more. If they're wrong, you still get diversification benefits from a small allocation.
If you invest in commodities through futures-based ETFs, you need to understand contango and roll yield; two concepts that significantly affect your returns.
Futures contracts expire. An oil futures contract for March delivery must be sold or settled in March. If you want to maintain your oil exposure, you must "roll"; sell the expiring contract and buy the next month's contract.
Contango occurs when future contracts are more expensive than near-term contracts. If March oil is $70 and April oil is $71, you sell at $70 and buy at $71; losing $1 per barrel each month. This "negative roll yield" erodes your returns over time.
Backwardation is the opposite; future contracts are cheaper than near-term contracts. This creates a positive roll yield that adds to your returns.
Oil futures have been in contango for most of the past 15 years, which is why USO has dramatically underperformed the actual price of oil. From 2007 to 2023, the spot price of oil might be roughly flat while USO lost more than half its value. The contango ate the returns.
This is why physically-backed commodity ETFs (like GLD for gold) are generally better investments than futures-based ones for long-term holders. No rolling, no contango; just direct exposure to the spot price.
If you want commodity exposure without dealing with futures complexity, there are several approaches:
Consider whether commodities belong in your portfolio. If you already hold a diversified stock and bond portfolio and want additional inflation protection or diversification, a 5-10% allocation to commodities — primarily through physically-backed gold ETFs or diversified commodity producer stocks — is a reasonable starting point.
Avoid overcomplicating it. You don't need to trade futures, time agricultural cycles, or speculate on oil prices. A simple allocation to gold and a broad commodity ETF provides the diversification benefits without the complexity.
If you add commodity positions to your portfolio, Clarity helps you track them alongside your stocks, bonds, crypto, and cash — all in one view. Understanding how commodities affect your overall allocation and performance is easier when you can see everything together rather than checking multiple apps and accounts separately.
This article is educational and does not constitute investment advice. Past performance does not guarantee future results. Consider consulting a financial advisor before making investment decisions.
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